Just the cost of government business

From an industry-risk perspective, the government-contracts industry is sort of a mixed bag.

On one hand, the business of government contracting is not especially volatile. Spending levels are pretty predictable, and generally resistant to market forces. For example, even though the tech industry is in the midst of a "social contagion" of layoffs, government-tech contractors (and agencies) are adding to their headcounts.

On the other hand, political winds can be pretty volatile! Even in procurement, which normally makes for boring political theater, shifting policy goals can make the work pretty difficult.[1] And, as a government contractor, you can get audited a whole bunch! As one author noted in an article a couple weeks ago: "As a former federal contracts attorney, I believe in only three certainties: death, taxes, and investigations."

And, with the 118th Congress and the House Oversight and Accountability Committee kicking off and signaling its intent to do more investigating, you really do get the impression that inspectors general, lawyers, and auditors will be pretty busy over the next few years.

The timing seems to be working out perfectly for the Government Accountability Office to publish an "exposure draft" of its revised "Government Auditing Standards," also know as the "Yellow Book". At a high level, the changes are subtle, mostly emphasizing a shift from "quality control" to "quality management" in the auditing organization's culture. My point here is that government auditing is having its moment in the sun.

Before you fall asleep, though, here's a fun study published in last month's International Journal of Auditing with the unassuming title "Government contracts and audit fees":

Using a sample of 43,547 firm-year observations for a period between 2001 and 2018, we find consistent evidence that audit fees are higher for firms having a higher proportion of government sales to total sales. The results are in line with the argument that auditors charge higher audit fees for the increase in audit effort resulting from the higher level of litigation risk and operational risks related to the long-run distortions in government contractors' competitive behaviours and innovation outcomes. The results are also consistent with the argument that auditors charge higher audit fees for firms relying more on government contracts to compensate for the potential losses from the audit engagements. Our survey of audit practitioners appears to support the argument that auditors perceive higher risk related to the audit of government contractors.

LOL!!! "Audit fees are higher for firms having a higher proportion of government sales to total sales"!

That's hilarious! Dollar for dollar, government contractors end up paying more for auditors than firms that are not in the govcon biz.[2] And why do government contractors pay more? A major reason is that government contractors are audited and investigated a lot! What an incredible deal for the auditors...

But wait. Before you start to think that maybe all that red tape and auditing isn't worth it, and maybe we should be more laissez-faire with the whole ecosystem, the study also suggests another industry-specific risk:

The survey participants note that government contractors' noncompliance with contract terms and the likelihood of misstatements of governmental contract revenues are the common risk factors related to the audit of government contractors. The audit practitioners state that in addition to the risk, the complexity and the timing of the audit engagement are additional factors determining audit effort and thus audit fees of government contractors.

What a world! Bad news: govcon's got a lot of noncompliance and misstated revenues that drives up auditors' risk. Good news: guess I'll have plenty to write about in the years to come!

[1] I'm looking at you, DOD's "Achieving Small Business Goals through Category Management Practices" and OMB's "Enhancing the Security of the Software Supply Chain through Secure Software Development Practices". I'll get to writing about you soon enough.

[2] An interesting tidbit: local government contractors have even higher audit fees than federal government contractors. The more you know, amirite?

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